Gold loan business is shining as regulatory scrutiny of sector grows

In mid-March this year, the finance ministry asked state-run banks to review their gold loan portfolio for the two-year period between January 1, 2022, and January 31, 2024.

This business had grown at a fast clip. Reserve Bank of India (RBI) data has it that it grew 15 per cent to Rs 1 trillion in FY24.

Now, in recent times, any kind of exuberance in financial services has seen the authorities swoop down – be it pushing the lines on governance or unsecured credit.

The ministry’s move came close on the heels of Mint Road barring IIFL Finance from vending gold loans over supervisory concerns.

Even as there are whispers that a decade after the K U B Rao Working Group to study ‘Issues Related to Gold and Gold Loans NBFCs’ submitted its report, a review may well be in order.

Is the surge in the gold loan portfolio of regulated entities merely the result of a surge in the yellow metal’s price?

Or, is it that that many customers, unable to avail of finance from formal sources, are overleveraging? It's a combination of both.

Space for more

As V P Nandakumar, managing director (MD) and chief executive officer (CEO) of Manappuram Finance, puts it: The significant increase in gold prices (of standard gold 10 gm by 16.1 per cent to Rs 73,144 in May over December 2023) has imparted stability to the gold loan book.

But it is only one of the many reasons for the rise in demand.

The penetration of formal players in this space is only 35 per cent, according to some estimates.

The rest still remain outside the pale of formal finance.

This is an opportunity for all players – banks, non-banking financial companies (NBFCs), including dedicated gold-loan firms and fintech.

Nandakumar feels NBFCs will continue to play a major role as they are nimbler than banks.

This is debatable if the crackdown on IIFL is anything to go by.

“There’s enough headroom for growth in the gold loan business,” says Madan Sabnavis, chief economist, Bank of Baroda.

He brings a different perspe­ctive.

The ratio of incremental gold loans to imports – at the systemic level – was at 0.60 in FY24.

It was at less than one for the previous two financial years as well, down from a high of 4.22 in FY20. For banks, this ratio stands at 0.35, almost back to the FY20 level of 0.43.

For NBFCs, (including those dedicated to gold loans), it’s at 0.25 (3.79).

“What it basically means is that compared to banks, NBFCs have more elbow room for growing this business,” he says.

Paul Thomas, MD and CEO of ESAF Small Finance Bank, agrees with the view.

“Our gold loan portfolio is at 12 per cent of our assets (at Rs 19,000 crore).

"The default rate is at around one per cent, and with gold prices on the rise, there’s enough buffer for borrowers,” he says.

This is because as gold prices go north, the loan-to-value ratio (LTV) at 75 per cent of the gold pledged also moves up.

RBI steps in

Another way of looking at it is the RBI’s regulatory measures: A hike in risk weights on certain segments of consumer credit by banks and NBFCs (plus bank credit to the latter), along with the strengthening of credit standards in the sub-segments of consumer credit may give a fillip to gold loans.

But there may well be a catch here too.

Jinay Gala, director of India Ratings & Research, says: “The RBI’s recent actions will increase the operational cost for players (in gold financing) due to higher compliance costs, heightened competitive intensity, and rising threshold for branch profitability.

"It’s a reference to the RBI imposing a cash disbursement limit of Rs 20,000.

"Nandakumar believes there’s no substance in the argument that gold loan NBFCs mi­g­ht lose business due to this regulation.

“The guidelines are applicable to all NBFCs; not just to those operating in gold loans.

"There are no additional compliance costs.”

Consider the RBI’s move to incentivise urban cooperative banks (UCBs) to meet their priority sector loan (PSL) target: It upped the monetary ceiling of gold loans granted under the bullet-repayment scheme to Rs 4 lakh (in October 2023) from Rs 2 lakh for UCBs which met the PSL target as of FY23.

As loan prices are expected to hold firm, is there a case for opening up the gold loan business to microfinance institutions (MFIs)?

“The new regulatory framework for MFIs allows them to lend for non-qualified assets up to 25 per cent of total assets.

"If some MFIs can develop capabilities for gold loaning, they can do this as a safe business,” says Jiji Mammen, executive director and CEO, Sa-Dhan.

Recall the lines of the preacher from the 1967 Hollywood hit, Mackenna’s Gold: “It (gold) can work for the Lord as well as the devil!"

The glitter is here to stay.